Pensions and Other Postretirement Benefits

1
Pensions and Other Postretirement Benefits

• Chapter 15
• UWYO COB ACCT2000

2
Learning Objectives

• Understand the economic consequences of pension
  plans
• Pension Expense
• Pension Liability
• Plan Asset
• Understand the feature of pension accounting
• Smoothing pension expense
• Make necessary adjustments

3
Types of Retirement Benefits

• Defined Contribution Plans
• Employer promises to contribute a certain amount
  to a plan each period
• Employee bears the risk of plan performance
• Employer recognizes contributions as pension
  expense each period
• Defined Benefit Plans
• Employer promises to pay employees a certain
  pension amount at retirement
• Employer bears the risk of plan performance
• Employer recognizes pension liability, asset, and
  expense each period

4
Example

• Current salary 100,000
• Total employment 20 years
• Annual compensation increase 3
• Final salary 175,351 (100,0001.0319)
• Discount rate 7
• Pension 2 per year of service
• 2 20 years 40 of final salary

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ExampleAfter One Year

• Projected annual pension 2 175,351 3,507
• 10-year pension is worth 26,356 at retirement
• 10-year pension is worth 7,288 currently
• Projected pension obligation (PBO) 7,288
• Service cost (an expense) 7,288

Receive 3,507 annual pension
Earn 100,000 with 3 annual increases
0
20 years
30 years
1 year
PV
7,288
26,356
6
ExampleAfter One Year

• If an employee quits early, use salary without
  increase to estimate employers obligation
• Accumulated benefit obligation (ABO)
• Use 100,000 instead of 175,351
• ABO 4,156
• An employee may only be entitled to a portion of
  ABO if she quits early
• Vested benefit obligation (VBO)
• Pension vests over 5 years, 20 per year
• VBO 20 ABO 831
• Another example P15-10

7
ExampleAfter Two Years

• Projected annual pension 22 175,351
  7,014
• 10-year pension is worth 52,712 at retirement
• 10-year pension is worth 15,596 currently

Receive 7,014 annual pension
Earn 100,000 with 3 annual increases
0
20 years
30 years
2 years
PV
15,596
52,712
8
ExampleAfter Two Years

• PBO
• 15,596
• ABO
• Use 103,000 instead of 175,351, ABO 9,161
• VBO
• 9,161 (2 20) 3,664
• Pension expense
• 15,596 - 7,288 8,308
• Interest on previous years obligation
• 7,288 7 510
• Service cost
• 8,308 - 510 7,798

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Sensitivity to assumptions
10
Pension asset and liability

• Employer invests in plans assets to prepare for
  future payoffs to employees
• If pension obligations gt plans assets
• net pension liability
• If pension obligations lt plans assets
• net pension asset

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Pension Expense

• Service Cost
• Attributed to work performed during the period
  (matching with revenue)
• Interest Cost
• Beginning PBO Discount rate
• Return on Plan Assets
• Beginning asset value rate of return

12
Accounting for pension expense

• Things causing volatile pension expense
• Volatile actual asset return
• Changes in pension assumptions
• Liability discount rate, life expectancy, etc.
• Asset expected return on assets
• Amendment of pension plan
• Adoption of new accounting standards
• Smooth reported pension expense
• Defer changes in plan assets and POB to future
  periods
• Amortize the deferred amount over time

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Accounting for Pension Expense

• Amortization of deferred gain or loss
• Due to volatile actual asset return
• Due to changes in pension assumptions
• Amortization of unrecognized prior service cost
• Due to amendment of pension plan
• Amortization of the transition liability or asset
• Adoption of new accounting standards
• An example P15-9

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Accounting for Plan Assets
15
Accounting for PBO
Example P15-8
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Accounting for net pension asset (liability)
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Pension analysis

• Are the assumptions and the change in assumptions
  reasonable (peer, industry, economy)?
• Are the unrecognized items reasonable?
• Did the company contribute enough to plan assets?
  
• example Case15-1 q1q2

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Pension adjustments

• B/S
• Use economic PBO and economic plan asset
  (example Case15-1 q3)
• I/S
• Exclude amortized items (example Case15-1 q3)
• Replace expected asset return with actual return
  (example Case15-1 q5)
• Classify interest cost and asset return as
  non-operating income (example P15-12)

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Summary

• Economic consequences of pension plans
• benefit plan
  contribution plan
• B/S
• I/S
• Pension accounting - smoothing
• Pension expense
• Plan asset PBO
• Recognized net asset / liability
• Adjustments
• B/S
• I/S

20
Problems Case

• Economic consequences of pension plans
• P15-1 (B), P15-2 (A), P15-3 (C), P15-4 (D), P15-5
  (B), P15-7 (D)
• P15-10 PBO 5,830, ABO 3,325 (follow lecture
  example, also in textbook)
• Pension accounting
• P15-8 29,000 4,100 29,000 8 500 600
  35,520
• P15-9 14 100 7 - 10 (60 - 10 100) / 5
  21 (underlined items are amortizations)
• Analysis adjustments
• P15-11 A 50,000 5,000, L 25,000 - 10,000 ?
  L/A27 (adjust Pension asset liability)
• P15-12 Operating Income 1,000 20,000 8,000
  13,000 ? OI/Sales26 (reclassify between
  operating / non-operating expense)
• P15-14 Average vesting rate (2040608010
  0)60 ? VBOABO600.72 billions ? ABO1.2
  billions gt Plan asset 1.0 billion ? under-funded
  (use the right amount of obligation)
• Case 15-1 comprehensive